Tuesday, March 28, 2017

The Post-Election Rally May Be Repealed And Replaced

By Doug Kass
Real Clear Markets
March 28, 2017

* Risk happens fast and the Trump trade may be over
* The administration's first initiatives have been ineffective
* A potential stock market top may now be in place

A Less Effective White House:
After Friday's failed health care bill, President Trump's future tax, regulatory and fiscal initiatives will be more difficult to accomplish. I have expected this outcome for several months; others may soon come to the same conclusion.

We soon may learn that:

* The president has and will continue to be educated that there is a fundamental difference between the art of the real estate deal and the art of delivering thoughtful legislation when 535 partisans are involved.

* I am fearful that President Trump will be unable to pivot; he maintains an overly visible and vocal contempt for his opposition in the media and in the Capitol. I am not sure whether he sees his Bannon-like anarchistic approach toward governing -- by tearing down Washington, D.C. -- is failing. His mistake is that though the populist message resonated pre-election, it must be expanded to get legislation passed post-election. We are a nation of laws, not of personalities. There are few sherpas within the administration who can guide and shepherd bills into successful laws. Every great corporate CEO or president of the U.S. knows what they don't know and they bring in brilliant, smarter and effective people to help them. However, even qualified Cabinet members such as Gary Cohn and Wilbur Ross have no experience on the Washington stage.

* The president's advisers lack knowledge of governing, have shown no ability to walk back from mistakes, and their early agenda has been ineffective (e.g., the travel ban has been declared unconstitutional and controversy has swirled around some appointees). Little has been achieved with the exception of a few executive orders, with no substance and less ability to be enforced. There has been no president in history who got stuck and lost at the start of his administration with a singular piece of legislation -- in this case the repeal and replacement of the Affordable Care Act (ACA). President Trump is likely to have many more firsts in his tenure.

* The administration now needs a win and the Supreme Court appointment of Neil Gorsuch may not be enough as Democrats now will fight tooth and nail against it. Indeed, the president, in his hostile tweets, press conferences and post-election stumping, has infuriated the Democratic Party, creating a toxic relationship.

* The bottom line is that unlike Friday morning or early November, there today is an unusual amount of policy uncertainty at a time when valuations are stretched by historic standards -- a potentially noxious combination.

I expect the president's popularity and approval ratings to continue to fray.

I also expect the President to get more and more frustrated in attempting to develop bipartisan coalitions for his agenda. (See Surprise No. 4 in my 15 Surprises for 2017)

President Trump may become the first part-time president in history, spending more and more time at Mar-a-Lago, Bedminster, N.J., and New York City. (See Surprise No. 5 in my 15 Surprises for 2017)

The Trump Presidency Likely Will Make Volatility And Uncertainty Great Again

Reduced Economic and Profit Expectations: A byproduct of a problematic, disorganized and less-effective administration will manifest itself in a lessened trajectory of domestic economic growth and U.S. profits.

The mother's milk of the S&P Index has been soured.

* Lower Interest Rates:
Even before the Friday ACA news, the yield curve already had been flattening, portending slowing growth. This flattening should continue. Interest rates likely will remain lower for longer, threatening financial institutions' promise, profitability and share prices (look at the Goldman Sachs GS chart as a template of concern). Here is the case I recently made to sell/short banks and selected financials. (This morning the yield on the 10-year U.S. note has slipped by four basis points to 2.36%, approaching its recent yield low)

I would put a laser-like focus on the 10-year U.S. note yield; dismissed by some, it will do what the consensus does not expect, in my opinion. It could fall. And with Federal Reserve Chairwoman Janet Yellen moving dovish and the very clouded bond short trade, a sharp drop in bond yields could scare the equity markets out of the "Trump Trade."

* Volatility Now May Rise:
The trend of more than 100 trading sessions without a 1% decline in the S&P 500 has been halted this past week. The problem is not that so many funds are trend-surfing (worshiping at the altar of price momentum); the problem is how much money is being committed on the same side (long) and essentially with the same strategy.

A 2017 Market Top May Be In Place


"The same principles which at first view lead to skepticism, pursued to a certain point, bring men back to common sense."


--George Berkeley

The irrational has been rationalized in recent months.

Skepticism is an historical tool that has been somehow lost since early November. (Our investment guard has been dropped and it's not "rope a dope.") Large skepticism leads to large understanding. Small skepticism leads to small understanding. And no skepticism leads to no understanding.

My market forecast, expressed in last December's 15 Surprises for 2017, remains the same:

"The S&P Index has a high of 2,375 (up 5%) for the year and a low of 1,815 (down 20%), closing the year closer to the low end of the annual price range (down 15%)."

This is no time to put our heads in the sand.

After Friday's withdrawal of President Trump's health care agenda, I expect stocks to weaken in a saw-tooth pattern (futures are down 20 this morning) , bonds to rally and to break recent price highs (yields on the 10-year are four basis points lower this morning), gold to advance (up $9 at 6 a.m. ET) and the U.S. dollar to drop (it is at a four-month low this morning).

Quite frankly, I do not understand much of the fabric of the recent bull market case anymore. Nor do I understand the logic that embraced the valuation optimism of a Trump election victory based on an aggressive tax, regulatory and fiscal agenda and that has dismissed the growing flaws and failures of the administration's policy.

With so many worshiping at the altar of price momentum and leaning on the same side of the investment boat -- having limited knowledge of private market value, replacement value, balance sheets or income statements -- their "views" may be temporary. (Remember those people were manifestly bearish if Trump won the election; well, they turned as the price momentum accelerated in November and December). Their convictions and investment backbones may not be strong or enduring; again, they are relying unduly, in my view, on the continuation of positive psychology, buoyed investor enthusiasm and on the emergence of animal spirits.

The market downside could be a function of the slope and trajectory of the correction and the sustainability of trend-surging influences that have been embraced by the long-only ETFs, CTAs, risk-parity and volatility-trending strategies shining. The robotic effect of rebalancing and strategies that worship at the altar of price and momentum are producing the impact of increasing risk and creating asymmetric reward versus risk. When the trends change, it will likely be abrupt and brutal.

With nearly everyone on the same side of the (long) boat, this has the potential to be one big feedback loop. But when the inflection point occurs, these funds sell lower after having bought higher.

Like in 1987, early 2000 and late 2007, this could be problematic.

It almost always ends badly when everyone is tilting to the same side.

President Trump will make volatility and uncertainty great again.


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